Becoming a 401(k) Millionaire
* Save 10% to 15% of Your Salary — or More.
This is boiled down multiplication. The more you save, the sooner you’ll become a millionaire.
Plus, you don’t have to worry about taxes until you pull the money out at a future date. :
“Fidelity’s 401(k) millionaires had an average company contribution of 5 percent.
In addition, those millionaires deferred about 14 percent of their pay over the 12 years they were studied, amounting to $13,300 a year. That made their total savings rate 19 percent. IRS rules allowed people to defer up to $17,500 of their pay in a 401(k) account in 2014 and as much as $23,000 if you were 50 and older.”
* Invest in Stocks.here
Let me refine this a bit: You need to invest in as many stocks as you can from all over the world.
Stocks have earnings and dividends. They pay you for being an investor and taking risk. Bonds don’t do that.
A fund like the Vanguard Total International Stock ETF (VXUS) owns nearly 6,000 stocks from across the planet. If you need a single stock holding, this would be a good choice.
“The 401(k) millionaires had an average of 75 percent of their assets in company stock and stock mutual funds. They had a median return of 4.8 percent over 12 years. Coupled with the contributions of themselves and their employers, their account grew 8.75 percent a year.”
Disclosure: I invest In low-cost Fidelity and Vanguard funds.
* Take the Employer Match.
This is the biggest financial no-brainer of all time. Somebody else is paying you to invest. It’s free money!
“When it comes to the millionaires, 28 percent in their account came from the employer and that boosted annual savings by nearly $4,600.”
* Don’t Cash Out.
Your 401(k) is not a piggy bank and it’s not an emergency fund. You should, of course, keep money in a money-market fund for rainy days, but it shouldn’t be in your 401(k).
The simple truth is that your money can’t compound if you pull it out and Uncle Sam will nail you with taxes and an early withdrawal penalty (before age 59 1/2). It’s not worth it.
So there you have it.
Save early and often and go for growth. Leave your money alone. If the stock market makes you nervous, keep only 60% in stocks and the rest in bonds and cash.
Although 401(k) vehicles are often flawed because of high expenses that you may never see, if offered the chance to save — and receive a matching contribution — there’s little reason to pass it up
Start saving at an early age. If you start saving for retirement
at age 25 and save $4,830 per year, or about $400 per month, and earn 7
percent annual investment returns, you will accumulate just over $1
million by age 65. If you wait until age 35 to start saving, you'll need
to save over $10,000 per year to hit $1 million by 65, assuming the
same investment returns. "For every 10 years that you delay, there is
going to be a significant increase in the amount you have to save," says
Danna Jacobs, a certified financial planner and founding partner of
Legacy Care Wealth in Jersey City, New Jersey. "You are missing out not only on the contributions but on the compounding interest."
Capture employer contributions. If your employer provides a 401(k) match,
you can get by saving a little less and still hit $1 million by
retirement. A worker who starts saving at 25 and gets a $1,500 annual
match could save $1 million by age 65 by tucking away as little as
$3,330 per year. A worker who starts saving at 35 and gets the same
match would need to tuck away $8,705 annually to hit $1 million by
retirement.
However, job changers
need to be careful that they get to keep the match. Many companies have
vesting schedules that prohibit departing employees from taking the
match with them until they work for the firm for a specific number of
years, or they allow workers to keep a portion of the match based on
their years of service. "Usually you do have to be with your employer
for a certain number of years, and sometimes you do leave your employer
contributions on the table," Jacobs says. "If it's a sizable amount, a
lot of times you can negotiate for a sign-on bonus with your new
employer to try to compensate you for those unvested amounts."
Save money on taxes. You can also use tax breaks
to grow your money faster. If you put $5,000 in a 401(k) and you are in
the 25 percent tax bracket, you will save $1,250 on your tax bill.
Income tax won't be due on your contribution until you withdraw it from
the account. "When you put the money in the 401(k), it reduces the
amount of income you have, so it's less tax you are paying at the end of
the year," says Anjali Jariwala, a certified financial planner for FIT
Advisors in Chicago. "The savings that you get from being able to defer
that income is huge."
However, it's important to note that you will
need to accumulate more than $1 million in a retirement account to have a
million dollars to spend in retirement because you still need to pay
income tax on each distribution. But if you save $1 million in an
after-tax Roth IRA, no income tax is typically due on distributions in
retirement.
Avoid high-cost funds.
Your investments will grow faster if you minimize the fees that are
deducted from your returns. If you save for 40 years between ages 25 and
65, but a 1 percent annual fee reduces your returns from 7 percent to 6
percent, you will need to save about $6,260 per year to reach $1
million by retirement, instead of $4,830 per year without the extra 1
percent fee. "You want to be really mindful of costs when it comes to
investing," Jariwala says. "Try to get to an allocation you want for the lowest cost possible."
Watch out for penalties.
Don't let retirement account penalties reduce your retirement savings.
There's a 10 percent early withdrawal penalty if you take money out of a
traditional IRA before age 59 1/2 and a 50 percent penalty if you fail
to start taking traditional IRA withdrawals after age 70 1/2. Also watch out for taxes and penalties
when rolling money over from a 401(k) to an IRA or new 401(k) when you
change jobs. "Create an IRA, and each time you leave a job, do a direct
rollover," says Michael Powsner, a certified financial planner and
founder of Upstart Wealth Management in San Francisco. "Make sure you
deposit the funds in the IRA in a timely manner from the time the 401(k)
cuts the check."
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